Business Context and Reporting Period
Company: HMS Income Fund, Inc. (MSC Income Fund, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2018
Business Overview: The Company is an externally managed, non-diversified closed-end management investment company operating as a Business Development Company (BDC). Its primary objective is to generate current income through debt and equity investments in lower middle market and middle market companies. The Company is managed by HMS Adviser LP, with MSC Adviser I, LLC (a subsidiary of Main Street Capital Corporation) serving as the sub-adviser.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net Investment Income | $14.85 million | $15.14 million |
| Net Realized Gain (Loss) | ($9.90 million) | $2.64 million |
| Net Change in Unrealized Appreciation | $10.60 million | ($4.52 million) |
| Net Increase in Net Assets from Operations | $15.56 million | $13.27 million |
| Net Asset Value (NAV) per Share | $8.17 | $8.16 |
| Total Portfolio Investments (Fair Value) | $1,067.64 million | $959.11 million (Q1 2017) |
| Cash and Cash Equivalents | $24.47 million | $41.43 million (Q1 2017) |
| Total Credit Facilities Outstanding | $458.00 million | $399.50 million (Average Q1 2017) |
| Weighted Average Effective Yield | 8.9% | 8.9% |
Material Changes vs. Prior Period
- Investment Income: Total investment income increased to $26.64 million from $25.36 million year-over-year, driven by portfolio growth and accretion of original issue discounts. However, Net Investment Income decreased slightly due to higher interest expenses and management fees.
- Realized Gains/Losses: The Company reported a net realized loss of $9.90 million, a significant reversal from the $2.64 million gain in Q1 2017. This was primarily due to sales of non-control/non-affiliate investments.
- Unrealized Appreciation: Net change in unrealized appreciation improved significantly to $10.60 million compared to a depreciation of $4.52 million in the prior year, largely driven by Middle Market debt investments.
- Leverage: Borrowings increased to $458.0 million (fully utilizing the EverBank facility and drawing down on the Deutsche Bank facility) compared to average borrowings of $399.5 million in Q1 2017. The annualized interest rate on borrowings rose to 4.4% from 3.7%.
- Portfolio Composition: The portfolio grew by approximately $7.6 million on a cost basis. The weighted average rating of the Lower Middle Market (LMM) portfolio improved slightly to 2.6 from 2.7.
Guidance, Outlook, Risks, and Unusual Items
- Fee Waivers: The Advisers waived subordinated incentive fees on income of approximately $15,000 and internal administrative services expenses of $804,000 for the quarter. No base management fees were waived.
- Non-Accrual Status: As of March 31, 2018, five debt investments in four portfolio companies were on non-accrual status, representing approximately 0.9% of the total portfolio at fair value. This is an increase from four investments in three companies at the end of 2017.
- Distributions: The Company declared distributions of $0.17 per share for the quarter. Approximately 64.1% of the distribution was funded from sources other than net realized income from operations (including prior year taxable income and fee waivers).
- Regulatory Changes: The Small Business Credit Availability Act (SBCAA) was enacted in March 2018, potentially allowing BDCs to reduce asset coverage requirements from 200% to 150%. The Company has not yet sought approval for this change.
- Share Repurchases: The Company repurchased 1,147,067 shares for approximately $9.4 million during the quarter. A subsequent tender offer for approximately 1.97 million shares was filed in April 2018.
- Interest Rate Risk: Approximately 88.6% of the debt portfolio contains floating interest rates. A 100 basis point increase in interest rates would increase net investment income by approximately $4.08 million, while a decrease would reduce it by $3.59 million.
Investor Verification Checklist
- Non-Accrual Portfolio: Verify the specific identities and credit status of the four portfolio companies with five investments on non-accrual status to assess potential future write-downs.
- Realized Loss Drivers: Review the specific portfolio sales that contributed to the $9.9 million realized loss to understand if they were strategic exits or distressed sales.
- Leverage Capacity: Confirm the Company's ability to maintain the 200% asset coverage ratio required by the 1940 Act given the current $458 million in borrowings and $112 million in remaining capacity.
- Distribution Sustainability: Analyze the sources of the $13.8 million distribution, noting that a significant portion (64.1%) was not funded by current net realized income.
- Fee Waiver Reimbursement: Monitor the "Operating Expense Ratio" and distribution rates to determine if previously waived fees (totaling millions over prior years) may become subject to reimbursement in future periods.